While insider trading is clearly illegal, defining it can be difficult, especially when considering arguably innocent banter between friends and family. Not all “tipper-tippee” situations are black and white, and courts have struggled to uphold consistent definitions of intent and personal benefit when it comes to prosecuting these cases.
The standards in defining personal benefit were tightened in the 2014 reversal of the insider trading convictions of Anthony Chiasson and Todd Newman in United States vs. Newman, significantly altering the government’s ability to prosecute insider trading cases, but the recent conviction of Sean Stewart put into question this apparent trend and possibly created greater uncertainty.
This October, the Supreme Court will revisit a 2015 insider trading case, Salman v. United States, which could create clearer standards of these disputed concepts, changing the way insider trading cases among friends and relatives are litigated in the future. But to understand the importance of Salman, let’s walk through a few insider trading cases that will be used to shape the decision this month.
Dirks v. Sec
Prior to 1980, courts held that if an insider tipped someone to moves within a company before they were officially disclosed to the public, the tipper and tippee committed fraud. However, with Dirks vs. SEC, the Supreme Court ruled that the emphasis should be placed on whether or not the tippee benefitted from the exchange, creating a personal-benefit-to-the-insider requirement.
Cases met this requirement if the insider benefitted from this exchange — often through a monetary incentive. The Court also argued that the insider in this scenario could have benefitted personally if he exchanged the material, nonpublic information to a “trading relative” or “friend.”
“So [the Supreme Court] talks about it like if you were my relative and I gave you something that you could convert into money, that’s almost as if I got money myself and gave it to you because of that kind of relationship,” explains Jon Eisenberg, partner at K&L Gates LLP.
However, what puzzled the government concerning the decision was that the Supreme Court found that, if there was no personal benefit to the tipper and there was no breach of duty in disclosing the information, it was ethical to for a tippee to trade on tipped information.
“That has puzzled the government forever. They don’t like it, they think it’s not a good standard. What they did after Dirks is they took that language about ‘friend’ or ‘relative’ and they sort of made everybody a ‘friend,’” says Eisenberg.
Thus, the term “friend” became an elastic word that the government used to avoid prosecuting cases where there was no clear-cut relationship between the tipper and tippees.
United States v. Newman
This 2014 case related to two people who traded Dell and NVIDIA Corp. (NVDA) stock; the tippees made $4 million and $68 million respectively on these stocks. In the case of the Dell stock, the Court ruled that the exchange was only to provide “career advice” to the tippee, as the tipper edited the tippee’s resume and sent it over to Wall Street — whether the tippee was interested in a job in the industry, and whether this was ethical, is another thing. In the case of the NVIDIA stock, an insider tipped off an acquaintance of his from church about company moves. The tippee never acted on it, but instead passed on that information to others, who again passed it on to others who were hedge fund managers. These hedge fund managers subsequently used this information to trade on the Dell and NVIDIA stocks.
While the government rule would have seen this relationship between the churchgoers as enough to satisfy the definition of “friends,” the Second Circuit overruled its definition and argued that the insiders had never acted for personal benefit and could not be charged with intent because the tipper became more and more removed from the tippee as information was passed down.
“Newman makes it much harder for the government to prove insider trading based on long chains of tippers and tippees to hold six or seven people in the chain liable, because the government would have to show that each person in the chain knew that the original tipper, and each tipper thereafter tipped in exchange for a valuable personal benefit,” explains Sam Lieberman, a partner in the Securities Litigation Group of Sadis & Goldberg LLP.
This case is also important because it not only rejected that a “friendship” was enough to charge someone with fraud, but the Second Court argued that there had to be an objectively obvious quid pro quo, where either the tippee or tipper had to receive some substantial benefit from the exchange. The Court also said that foresight from the tippee that they should have known about a breach was not a valid point.
Overall, many saw Newman as a setback for prosecutors because it challenged Dirk’s personal-benefit-for-the-tipper test concerning relationships between tippers and tippees and evidence of a clear quid pro quo between the two, making it harder for lawyers to challenge certain insider trading cases.
United States v. Sean Stewart
In late August of this year, a Federal jury convicted Sean Stewart of insider trading. Stewart was an investment banker for JPMorgan Chase who tipped off both his father, Robert Stewart, and a friend of his to five different moves with the firm, amounting to $150,000 and nearly $1 million respectively after they had each traded on the information.
Revisiting the Newman case, it’s not enough in this scenario to convict the son of illegal insider trading because the relationship alone could not satisfy the personal benefit test. A substantial quid pro quo would have to be proven instead. So prosecutors got creative and found that the father had paid for the son’s wedding photographer and rehearsal dinner for his son’s wedding — coincidentally around the time the trades were made. Thus, the Newman case was turned on its head since this case proved that gifts between relatives could now be enough to provide a personal benefit to the insider.
“So, the pre-Newman lower standard of merely requiring a ‘gift’ to a trading friend or relative made it much easier for prosecutors and regulators to prove their cases,” says Lieberman. “Newman and Stewart dramatically change the landscape of insider trading investigations, because it is often difficult for prosecutors to find the smoking-gun ‘bag of money’ that was used to get a person to tip inside information.”
the next case to watch:
Salman v. United States
This October, the Supreme Court will make a decision regarding an insider trading case regarding information between relatives. In Salman, a Citigroup banker shared information concerning company moves with his brother, who in turn shared this information with his brother-in-law, who in turn shared it with one of his relatives. A red flag went up on both the banker’s brother and brother-in-law’s relative, Salman, who were both making identical trades on company moves.
As a result, Salman was charged with insider trading. Salman argues that there isn’t enough evidence to prove that he was trading on insider information but the court of appeals argues that the close family relationship he held with the tipper is enough proof. The Supreme Court’s role will be to create a better definition in relation to how personal relationships (friendships and relatives) come into play when prosecuting insider trading cases.
“This term the [Supreme Court] is going to decide one way or another what the standard is and it could accept a Newman type test, it could reject the Newman type test, it could come up with something in the middle. But it means that they’re likely to resolve some of the uncertainties that currently exist,” says Eisenberg.
For Lieberman, he sees the Court’s decision meeting in the middle between Dirks and Newman.
“The likely result of the Salman Supreme Court case is that the Supreme Court will hold that there can be tipper-tippee liability for tipping your brother or brother-in-law, even if no money was exchanged between tipper and tippee. Where you have a very close family relationship between tipper and tippee, the act of tipping inside information can be viewed as equivalent to enriching yourself through your family,” says Lieberman. “I think the Supreme Court will clarify that for a very small category of close family relationships, or relationships where people are thick as blood, it can be sufficient to rely on the very close relationship to prove tipper-tippee liability. For other cases, I believe, the Court will require a real, quid pro quo personal benefit exchange for liability.”